Negative-Sum Game

Class action lawyers like to crow about how much money they recover for shareholders, but much of the windfall comes from their clients' own pockets, a kind of robbing Peter to pay ... Peter. Face it: Whether the proceeds come from the company or its insurers, investors ultimately foot the bill. "You're just taking money out of one pocket and putting it in the other," says Keith Johnson, chief counsel for the State of Wisconsin Investment Board.

Even when investors in, say, WorldCom, exact recompense from an outside party such as the company's banker, Citigroup, big institutions and anyone who owns a large-cap index fund likely are just taxing themselves. Lawyers, of course, disagree. "Most of our clients sold stock [at a loss] due to a wrong, and they're entitled to recourse," says Max Berger, senior partner at Bernstein Litowitz Berger & Grossmann. "That current shareholders [ultimately] pay for it is unfortunate but doesn't mean the company shouldn't pay."

Last year securities-fraud settlements ran an average of $21 million per case, and half of all settlements came in at less than $6 million, says Cornerstone Research. Big companies typically buy $40 million or more in insurance coverage for directors and officers, so they are mostly covered. To public companies, that makes such suits just another cost of business. But it's a rising one: The median price for D&O insurance rose 61% in three years to $50,000 in 2003. Class actions are a growth business for insurers and for law firms on both sides of the table.

Oxford Health last year settled a case for $300 million, with $75 million coming from its accountants. The company also took a $182 million pretax charge for the amount not covered by its insurance. The result was a cash dividend paid to former Oxford shareholders by current ones. Anyone who held on throughout paid himself-minus $84 million in fees for the plaintiff lawyers.

A rare exception is a Wisconsin suit against Anicom. The $40 million settlement included $12.4 million from Anicom's former chairman, Alan Anixter, and his son, Scott. That is because Wisconsin hired outside the usual lawyer pool and dangled a 5% "kicker" for any money won from other parties.